1. Suppose an investment project has an NPV of $150 million if it becomes successful and an NPV of ?$50 million if it is a failure. What is the minimum probability of success above which you should make the investment?
a. 0.5
b. 1/3
c. 0.25
d. 0.1
2. Your production line has recently been producing a serious defect. One of two possible processes, A and B, could be the culprit. From past experience you know that the probability that A is causing the problem is 0.8 but investigating A costs $100,000 while investigating B costs only $20,000. What are the expected error costs of shutting down process B first?
a. $80,000
b. $20,000
c. $16,000
d. $4,000
3. You want to price posters at the Poster Showcase profitably and run an experiment to estimate the demand elasticity. You raise the price of kitten posters 10% but keep your dog poster prices unchanged. After a month, kitten poster unit sales fall by 12%, but dog posters rise by 8%. Why might the elasticity estimate from this experiment be biased?
4. Tennessee just instituted a state lottery. The initial jackpot is $100,000. If the first week yields no winners, the next week's jackpot goes up, depending on the number of previous players who placed the $1 lottery bets. The probability of winning is one in a million (1.0 × 10?6). What must the jackpot be before the expected payoff is worth your $1 bet? Assume that the state takes 60% of the jackpot in taxes, that no one else is a winner, and that you are risk neutral (i.e., you value the lottery at its expected value).
5. An insurance company offers doctors mal-practice insurance. Assume that malpractice claims against careful doctors cost 5,000 on average over the term of the policy and settling malpractice claims against reckless doctors costs 30,000. Doctors know whether they are reckless or careful, but the insurance company only knows that 10% of doctors are reckless. How much do insurance companies have to charge for malpractice insurance to break even?
a. $5,000
b. $7,500
c. $27,500
d. $30,000
6. An employer faces two types of employees. Regular workers are 70% of the population and generate $100,000 in productivity. Exceptional workers are 30% of the population, and generate $120,000 in productivity. Employees know their types, and reject salaries below their productivity. If the employer offers a salary equal to the average productivity in the population, what will be the employer's per-employee profit?
a. ?$10,000
b. ?$6,000
c. $0
d. $4,000
7. In the late 1990s, car leasing was very popular in the United States. A customer would lease a car from the manufacturer for a set term, usually two years, and then have the option of keeping the car. If the customer decided to keep the car, the customer would pay a price to the manufacturer, the "residual value," computed as 60% of the new car price. The manufacturer would then sell the returned cars at auction. In 1999, the manufacturer lost an average of $480 on each returned car (the auction price was, on average, $480 less than the residual value).
A. Why was the manufacturer losing money on this program?
B. What should the manufacturer do to stop losing money?
8. Soft selling occurs when a buyer is skeptical of the usefulness of a product and the seller offers to set a price that depends on realized value. For example, suppose you're trying to sell a company a new accounting system that will reduce costs by 10%. Instead of naming a price, you offer to give them the product in exchange for 50% of their cost savings. Describe the information asymmetry, the adverse selection problem, and why soft selling is a successful signal.